Market Musings....Tuesday, January 7, 2014
No earth-shaking events have occurred of late to alter the global macro view of a world that is growing, albeit slowly, held back by persistent hangovers of the ill-effects (high unemployment, troubled national budgets and debt levels, and abundant capacity under-utilization) of the 2008 financial debacle, along with geopolitical headwinds that keep tensions high in the energy-rich Middle East region, and more broadly in conflicts between China and Japan, or North Korea and South Korea. The flood-gates of global central bank stimulus have helped keep the global economic engine running, and while massive liquidity raises concerns about potential inflation, at the moment, there appears to be more concern about DE-flation than IN-flation! As such, the ECB and the BOJ are expected by most market participants to continue with their feet on the accelerator, while the Yellen Fed is expected to taper its tapering to a slow rate creep higher rather than a rate spike (just take a look at EM countries with high current account deficits if you think the Fed could do otherwise)..
China's recent PMI data, both for Manufacturing and Services, were below expectations and slowed from prior months, but still broadcast expansion. Couple that with the "Plenum" reforms which, while playing out over an extended period of time, are aimed at keeping China on a path for further re-balancing of growth towards domestic spending, less 'shadow banking bubble' risk, more financial discipline at all levels, and GDP growth at 7+%. Time will tell, and everything is in the execution of the plan, but if it plays out well, there's room for optimism that China could emerge in '14 as more of a global engine of growth.
Japan's meteoric stock market rise in '13 has to be troubling to anyone who believes in "what goes up, must come down", but beyond simple truisms, the economic rationale might be that the equity markets have seemingly fully priced in a total and complete success of Abe-nomics! Any shortfall in economic optimism along the way, for example, after the imposition of the new sales tax this spring which could slow growth, might cause the equity markets to give up lots of the built-in success premium. Granted, US tapering, which is likely to keep the USD strong vs the Yen, should help Japanese exporters, but that theme has been the wind in the sails of the Nikkei to date. One has to wonder how much further a weak Yen can propel the Nikkei, especially when imported energy bills are climbing!
Europe continues to ride the wave set in motion in the Summer of 2012 with Draghi's "we'll save the Euro at all costs" seeming guaranty. This extended period of relative calm in European markets, especially given how low rates have been, has helped on several fronts. Spanish and Italian 10yr yields have been enjoying levels at just over 4% for some time, helping meaningfully on their respective debt burdens. That said, the story of the Eurozone is really one of the Tale of Two Cities, with one "City" being Germany, reviled for relying on export growth for its own economic success and not doing enough to promote domestic spending, and the other "City" being peripheral countries (and France) who are still bogged down with fiscal deficits, huge debt overhangs and massive (and tragic) levels of unemployment. Can the Draghi parachute for the Euro continue to not only hold it up but also catch a rising wind gust to propel it even higher? And if it does, will that choke off exports from the EZ that are crucial for fiscal targets? How Europe has avoided the riots in the streets that we witnessed back in 2011 and to a lesser degree in 2012 is amazing, but just because it hasn't happened doesn't mean it's no longer a real risk to the European outlook.
Middle East tensions won't help. Turkey is feeling the ill-effects of the Syrian civil war on its border, and Iraq is breaking down into heightened levels of sectarian violence, all while Israel and Lebanon have lethal clashes at the border, and while Iran continues to support Hezbollah and the Syrian Asad regime. Throw into the mix a rather violent war in South Sudan, and you have a heightened oil-supply-disruption risk, which given how dependent Europe, China and Japan are on Middle Eastern oil, could disrupt the current economic optimism.
Collectively, the assessments above produce the cautiously optimistic view that we've had on equity markets for some time. The 'cautious' part of that view has had us holding higher levels of cash than we have historically. The 'optimistic' part of that view has had us investing in various global macro thematic value opportunities in a number of places such as the tech, energy and consumer discretionary sectors. Ultimately, how we pivot in terms of more or less 'caution' vs 'optimism' will be heavily influenced by earnings: what earnings expectations are priced into stocks vs what earnings are likely to be. We'll be sharing more on this as Q4 earnings season gets under way later this week.
In future Market Musings, we'll discuss our investment themes in more specific detail and the positions that we've taken to express those views. In the meantime, we'd love to hear your thoughts! Please share them broadly via commenting below, or privately to us via the 'chat' or 'email' options to the right.
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